Its an automatic mechanical system. When the shifter is in hi, it is actually rear wheel drive until it the rears start spinning faster than the front. That will cause pressure build up in the transfer case and transfer power to the front wheels. It is a progressive system and can send as much power as is needed to the front or rear until they are spinning at the same speed. Fuel mileage would not change at all, even if you did have a dedicated 2wd mode since our axles are "live" in that you can not disengage the hubs, so everything in the axle is always turning and creating friction.
In lo mode, it lowers the gear ratio for more torque, and physically locks the front and rear drive shafts together so that they are always spinning at the exact same speed. Never Ever Ever use this mode on dry pavement.
2002 Overland - 4.7 HO, "Select-Drive", 4" RC long arms, TAG front winch bumper, 32" BFG KM's, Kolak 3" exhaust, Flowmaster 50 series